We think you have liked this presentation. If you wish to download it, please recommend it to your friends in any social system. Share buttons are a little bit lower. Thank you!
Presentation is loading. Please wait.
Published byGreyson Pyle
Modified over 2 years ago
© K.Cuthbertson and D.Nitzsche LECTURE RISK GRADES™ : J.P Morgan Version 1/9/2001
© K.Cuthbertson and D.Nitzsche Data on Returns and Volatility RiskGrades™ (J.P. Morgan) Risk Grades for Various Portfolios Topics
© K.Cuthbertson and D.Nitzsche Data on Returns and Volatility
© K.Cuthbertson and D.Nitzsche HOW RISKY ARE STOCKS? US - STOCK RETURNS: LONG TERM (1929-54) June 22nd, 1929$10,000 Sept 3rd, 1929$12,417 (+25%) Oct 29th, 1929$ 7,495 July 1932$ 1,342 (-86%) 1954$10,000
© K.Cuthbertson and D.Nitzsche Jan 1973$10,000 Dec 1974$ 6,600 (-34%) 1983$10,000 US - STOCK RETURNS: LONG TERM (1973-83)
© K.Cuthbertson and D.Nitzsche Jan 1988$10,000 Dec 1989$18,342 July 1992$ 6,708 (-33%) Jan 2000<$10,000 JAPAN - STOCK RETURNS: (1988-2000)
© K.Cuthbertson and D.Nitzsche MeanS.D. Large US stocks1.0295.7%(per month) Normality Only 1% of the time should monthly stock return fall below 1.029 - 2.33(5.7%) = -12.25% 1929-97 = 828 months How many returns more negative than -12.25%? Normality = 8.3Actual = 16 ! Never, trust the ‘normal’ ! US STOCKS: SHORT TERM (Monthly 1926-97)
© K.Cuthbertson and D.Nitzsche RiskGrades™ (J.P. Morgan)
© K.Cuthbertson and D.Nitzsche A ‘simplified’ method of calculating the changing risk (usually daily) of a portfolio of assets, for use by individual investors and ‘small’ financial institutions. Measures change in risk in a transparent and simple way The returns on the portfolio are ignored (in large part) Concepts based on elementary portfolio theory RiskGrades measures volatility ( ) as the S.D. of a portfolio of assets. is usually measured as an EWMA of past squared (daily) returns ( r t = ln(P t /P t-1 ) ) - using = 0.97 and about 150 days/values for r t RiskGrades™ : What is it ?
© K.Cuthbertson and D.Nitzsche 1) “Portfolio Risk Grade” Risk of portfolio (relative to 20% risk of a ‘world’ benchmark) 2) Undiversified Risk Grade ~ worse case outcome 3) Diversification Benefit = (2) - (1) 4) Marginal Risk Impact = increase in risk as you add (or subtract) one or more assets from your portfolio Statistics Used
© K.Cuthbertson and D.Nitzsche i is the DAILY standard deviation base is fixed at 20% per annum(=av. for international stocks) Hence RG is just a “scaled” standard deviation e.g. If RG = 100% then asset has 20% p.a. ‘absolute’ risk e.g. If RG 1 = 100 and RG 2 = 400 then asset-2 currently has 4 times the risk of asset-1 RiskGrades™ (single asset)
© K.Cuthbertson and D.Nitzsche VCV = variance-covariance matrix of RG Undiversified Risk Grade(Worse case) Undiversified RG = all w>0 Diversification Benefit = URG - RG RISK GRADE (Portfolio)
© K.Cuthbertson and D.Nitzsche $RI = RG p (n) - RG p (n-j) = risk grade whole portfolio – risk grade excluding one (or more) assets Funds released are held in cash (zero risk/correlation) %Percent Risk Impact of omitted asset – j % RI = Can RI ever increase as you ‘drop’ an asset ? $ RISK IMPACT of omitted asset (= j)
© K.Cuthbertson and D.Nitzsche RiskGrades™: FT 19/10/00 (for Oct 17th) BONDSEQUITYFX(rel to USD) Europe2586(135)62(Euro) Americas3294(146)49 Asia2198(139)39(Yen) Global38107(156)…. UK77 (115) Note: (..) = 52-week high 100 = average volatility of international equity mkts (equiv, to 20% p.a. absolute volatility).
© K.Cuthbertson and D.Nitzsche An Example ($10,000 in each of 2 assets) WeightsRisk Grade%R.I. Coca-Cola½18828 Cisco½17925 Portfolio125 Diversification58.5 The Risk Grade for various stock indices are now published daily in the Financial Times. Risk Measures
© K.Cuthbertson and D.Nitzsche 1) Cola’s RG is ‘9’ more than Cisco’s RG - what does this mean? 2) What is the ‘Undiversified RG’ and the ‘Diversification (RG) effect ? Class Exercise: Interpretation of the Figures
© K.Cuthbertson and D.Nitzsche 3)How do we get the figure of 28% for the Percentage Risk Impact of Cola and what does this 28% mean? Hint: Note that when you remove Cola, then these funds are held in cash(with zero risk) and you continue to hold only Cisco. Class Exercise: ‘Risk Impact and %R.I.’
© K.Cuthbertson and D.Nitzsche P t = DPV (y t C, M, n) Use historic(daily) y t to calculate ‘simulated’ P t. (n, C and M are ‘fixed’ by the bond you hold) Capital gain = ln(P t /P t-1 ) “Return” = CG + y t /252 Calculate S.D. of ‘Return’(I.e EWMA using 150 days past data) Illustrative RG for Government Bonds (different maturities) RG (¼, ½, 1, 10, 30yr) = 1, 2, 3, 26, 43 respectively What does RG=43 for 30 year bond mean? What is it so much larger than RG=3 for 1-yr bond? RiskGrades for Bonds
© K.Cuthbertson and D.Nitzsche Black-Scholes Formula C t = BS(S t, r t, , T, Div) Use historic values of 1 st, 2 variables. Construct artificial data series for C t (with , T, Div fixed): “Return” = ln(C t /C t+1 ) Calculate S.D. of Return Are there any dangers in this method ? Can it be applied to all options ? Risk Grade for Bonds
© K.Cuthbertson and D.Nitzsche Risk Grades for Various Portfolios
© K.Cuthbertson and D.Nitzsche Price/ValueR. GradeR. Impact % Cisco107.12517971 Call18.12566529 Div.Ben22 Portfolio125.25227 What is the ‘undiversified RG’ and why is the ‘Div Benefit’ rather low at ‘22’? Intuitively, why is the RG of the call relatively high at ‘665’? (Hint: assume it’s ‘delta’ is say 0.5) - tricky! Portfolio = 1 share Cisco +1 At-the-money call on Cisco
© K.Cuthbertson and D.Nitzsche PriceR. Grade %R. Impact Cisco107.12517941 Put11.75600-58 Div. Ben119 Portfolio118.875102 Why is the diversification benefit relatively high at 199 Intuitively what does a %R.I of -58 mean? Portfolio = 1 share Cisco + 1 At-the-money Put
© K.Cuthbertson and D.Nitzsche a) $10,000 in Cola - all own funds b) $10,000 in Cola, $5000 borrowed funds(ignore interest cost) a)$’sRisk Grade%R.I. Cola10,000188 100 Cash00 : Div. Benefit0: : ‘Portfolio’10,000188 : b)$’sRisk Grade%R.I. Cola10,000188 100 Cash-5,0000 0 Div. Benefit:0 : ‘Portfolio’5,000376 : Intuitively, why has RG of ‘portfolio’ increased to 376. Is there an obvious formula in this simple case? RiskGrades with purchases ‘on margin’(=Leverage)
© K.Cuthbertson and D.Nitzsche Intuitively, why is RG=376 relatively high? Intuitively, why is there a ‘R.I.’ for ‘cash’ whereas there was no such effect for purchases ‘on margin’ ? RiskGrades with purchases financed from ‘short sales’
© K.Cuthbertson and D.Nitzsche a) $10,000 in Cola - all own funds b) $10,000 in Cola using $5000 funds obtained from short selling Cisco (ignore any ‘haircuts’) a)$’sRisk Grade%R.I. Cola10,000188 100 Cash0: : Div. Benefit0: : ‘Portfolio’10,000188 : b)$’sRisk Grade%R.I. Cola10,000188 58 Cash-5,000179 12 Div. Benefit:127 : ‘Portfolio’5,000376 : RiskGrades: purchases financed from ‘short sales’
© K.Cuthbertson and D.Nitzsche END OF LECTURE
© K.Cuthbertson and D.Nitzsche 1) RG (Cola) – RG(Cisco) = 188-179 = 9 [i.e. Cola is 1.8%p.a. (= 9 x 20%/100) more volatile than Cisco in absolute terms]. 2) Undiversified RG = (½)(188)+(½)179 = 183.5 Hence: Diversification effect= 183.5-125 = 58.5 3)Risk Impact of Cola(extreme case of only 2 assets) %RI(Cola)= Note that ‘179’ is Cisco’s risk grade. Note (½) in Cisco and ½ is held in cash (with zero risk). Interpretation of Figures (see above slides)
© K.Cuthbertson and D.Nitzsche Removing Cola from the portfolio would reduce RG by 35.5 which is equivalent to 7% of the annual S.D. (= 35.5 x 0.20) Removing Cola from the portfolio would reduce the risk grade in percentage terms by 28% (I.e. compared with the RG of the initial 2-asset portfolio) This 28% reduction in risk is primarily due to the fact that in the initial 2-asset portfolio you hold 2 x $10,000 in risky assets while after removing Cola you only hold $10,000 in risky assets (The other $10,000 is held in cash). Interpretation of ‘Risk Impact’
© K.Cuthbertson and D.Nitzsche END OF SLIDES
Introduction The relationship between risk and return is fundamental to finance theory You can invest very safely in a bank or in Treasury bills. Why.
Portfolio Management Lecture: 26 Course Code: MBF702.
CHAPTER SEVEN Risk, Return, and Portfolio Theory J.D. Han.
Value at Risk Chapter 16. The Question Being Asked in VaR “What loss level is such that we are X % confident it will not be exceeded in N business days?”
Risk Management and Financial Institutions 2e, Chapter 13, Copyright © John C. Hull 2009 Chapter 13 Market Risk VaR: Model- Building Approach 1.
© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible Web site, in whole or in part.
Copyright K.Cuthbertson, D. Nitzsche 1 FINANCIAL ENGINEERING: DERIVATIVES AND RISK MANAGEMENT (J. Wiley, 2001) K. Cuthbertson and D. Nitzsche Lecture.
Investment Analysis and Portfolio management Lecture: 24 Course Code: MBF702.
Risk and Return – Part 2 For 9.220, Term 1, 2002/03 02_Lecture13.ppt Instructor Version.
LECTURE 1 : THE BASICS (Asset Pricing and Portfolio Theory)
Security Analysis & Portfolio Management “RISK & RETURN” By B.Pani M.Com,LLB,FCA,FICWA,ACS,DISA,MBA
Copyright © 2009 Pearson Prentice Hall. All rights reserved. Chapter 5 Risk and Return.
Chapter 21 Value at Risk Options, Futures, and Other Derivatives, 8th Edition, Copyright © John C. Hull 2012.
Chapter McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. A Brief History of Risk and Return 1.
Chapter 10: Risk and return: lessons from market history
Copyright K.Cuthbertson, D. Nitzsche 1 FINANCIAL ENGINEERING: DERIVATIVES AND RISK MANAGEMENT (J. Wiley, 2001) K. Cuthbertson and D. Nitzsche Lecture VaR:
FINANCE IN A CANADIAN SETTING Sixth Canadian Edition Lusztig, Cleary, Schwab.
The Trade-off between Risk and Return
Fundamentals of Futures and Options Markets, 5 th Edition, Copyright © John C. Hull Value at Risk Chapter 18.
A History of Risk and Return
© K.Cuthbertson and D.Nitzsche 1 Lecture Stock Index Futures Version 1/9/2001 FINANCIAL ENGINEERING: DERIVATIVES AND RISK MANAGEMENT (J. Wiley, 2001) K.
CHAPTER 8 Risk and Rates of Return
RISK VALUATION. Risk can be valued using : Derivatives Valuation –Using valuation method –Value the gain Risk Management Valuation –Using statistical.
Risk and Return – Introduction For 9.220, Term 1, 2002/03 02_Lecture12.ppt Student Version.
WSU EMBA Corporate Finance12-1 Chapter 12: Risk, Cost of Capital, and Capital Budgeting Weighted Average Cost of Capital (WACC) Estimating cost of capital.
Risk, Return, and Discount Rates Capital Market History The Risk/Return Relation Application to Corporate Finance.
© 2008 Morningstar, Inc. All rights reserved. 3/1/2008 LCN Portfolio Performance.
© 2009 Cengage Learning/South-Western The Trade-off Between Risk and Return Chapter 6.
Berlin, Fußzeile1 The Trade-off Between Risk and Return Professor Dr. Rainer Stachuletz International Markets and Corporate Finance Berlin School.
© K.Cuthbertson, D.Nitzsche 1 LECTURE Market Risk/Value at Risk: Basic Concepts Version 1/9/2001.
Lecture 4 Portfolio Tools.
©K.Cuthbertson and D.Nitzsche 1 FINANCIAL ENGINEERING: DERIVATIVES AND RISK MANAGEMENT (J. Wiley, 2001) K. Cuthbertson and D. Nitzsche LECTURE Dynamic.
Options, Futures, and Other Derivatives, 6 th Edition, Copyright © John C. Hull The Black-Scholes- Merton Model Chapter 13.
1 Value at Risk Chapter The Question Being Asked in VaR “What loss level is such that we are X % confident it will not be exceeded in N business.
Chapter 10 Capital Markets and the Pricing of Risk.
Options, Futures, and Other Derivatives, 5th edition © 2002 by John C. Hull 16.1 Value at Risk Chapter 16.
© 2013 Pearson Education, Inc., publishing as Prentice Hall. All rights reserved.12-1 Option Greeks (cont’d) Option elasticity ( describes the risk.
Options, Futures, and Other Derivatives 6 th Edition, Copyright © John C. Hull Chapter 18 Value at Risk.
Value at Risk Chapter 20 Options, Futures, and Other Derivatives, 7th International Edition, Copyright © John C. Hull 2008.
MTH 105. FINANCIAL MARKETS What is a Financial market: - A financial market is a mechanism that allows people to trade financial security. Transactions.
Chapter 22 Principles PrinciplesofCorporateFinance Ninth Edition Valuing Options Slides by Matthew Will Copyright © 2008 by The McGraw-Hill Companies,
1 The Black-Scholes-Merton Model MGT 821/ECON 873 The Black-Scholes-Merton Model.
Copyright © 2009 Pearson Prentice Hall. All rights reserved. Chapter 8 Investor Choice: Risk and Reward.
Risk and Return in Capital Markets
Lecture 1- Part 2 Risk Management and Derivative by Stulz, Ch:2 Expected Return and Volatility.
Investment in Long term Securities Investment in Stocks.
Lecture Topic 9: Risk and Return
Chapter 4 Introduction This chapter will discuss the concept of risk and how it is measured. Furthermore, this chapter will discuss: Risk aversion Mean.
CORPORATE FINANCIAL THEORY Lecture 10. Derivatives Insurance Risk Management Lloyds Ship Building Jet Fuel Cost Predictability Revenue Certainty.
© 2017 SlidePlayer.com Inc. All rights reserved.